A Creative $700B Plan That Would Solve Problems

I’m an avid reader of David Merkel, and feel his blog has really helped me grow in my understanding of the markets. So when I read his call to oppose the Treasury bailout, I had some thinking to do. I know I could work wonders with $700 billion, and it seems like the political zeitgeist is fully behind some form of funding for a purchase-crap-and-recapitalize plan. I recognize that, but I think there’s a worthwhile alternative that needs to be taken alongside… bear with me, please.

Why not split the money between purchasing mortgages that are current or delinquent but not in foreclosure as of Q2 or Q3 2008 (to prevent the passing along of crap to the greatest extent possible) with the intention of helping these homeowners carrying mortgages keep their homes, and using the rest to start buying up homes for sale on the market?

The first part is fairly straightforward – once the government has the mortgage, they can go to just about any length to keep these people in their homes. The goal of this is twofold: first, actually try to do some good for a group of taxpayers, and second, to stop foreclosures before they bring more inventory to market. Now, it might not be fair or equitable to save borrowers who have recently become delinquent and allow them to refinance both rate and term with the help of cheaper government borrowing, but I doubt the people just becoming delinquent now are the speculators who pushed the housing market to a top. Plus, for everyone who complains that they were prudent and aren’t getting “bailed out” by the government, realize that the probability is high the government either owns or is guaranteeing your mortgage.

The second part of my $700 billion package is where I’m trying to get creative and offer a new idea. My math says half that amount could purchase about 1.6 million “typical” homes based on a recent median home price estimate of $212,400. Use the houses to put up new immigrants with in-demand degrees, members of the military (be they presently serving or recently discharged), and recent graduates who will do work beneficial to society, like Teach for America. With unsold housing inventory recently estimated at just over 4.6 million units, bringing this down to 3 million units would put effective months supply around 7.2 – still elevated, but a marked improvement from the existing 11+ months. And, once this bubble unwinds and finds a bottom, there will be plenty of opportunities for the government to eventually sell the properties back once supply and demand are more in-line.

In short, I think my hypothetical scenario would be a more effective solution to protecting taxpayers, while fulfilling several key goals – keeping people in their homes, giving the government equity for their capital that can be leveraged to jumpstart high-growth fields, education, and/or service, and putting a soft floor under home prices by creating a huge marginal buyer.

I want to emphasize the last point, because from a financial perspective it’s the most important. Supporting housing prices directly would tilt the economics of default and foreclosure in favor of staying current on payments, but not in a way that explicitly rewards the institutions with shoddy underwriting/purchasing standards. If you were writing extremely high LTV no-docs, this is not going to help much… but if you might have allowed some borrowers to stretch with 10% down, and now they’re just above break-even due to declining home prices, this could stem the bleeding of their equity they’re seeing.